Weather and investment strategies are closely related. This becomes especially true if you are directly or indirectly invested in commodities. For example, quantity of rainfall in Malaysia is closely monitored by investors in the U.S. Malaysia is the second-largest producer of palm oil in the world, and a change in rainfall means a change in production. And of course, a change in supply will have a significant impact on the palm oil prices. The amount of impact will be decided by whether you are directly invested in palm oil as a commodity, bought shares of a company that produces or distributes it, or invested in a mutual fund/ETF that invests in that sector.
Since we are approaching wintertime, it is useful to see what the impact on your portfolio might be.
How Will This Winter Affect Your Portfolio?
According to Environment Canada – forecast for the next three months (peak winter months) – the phenomenon called El Niño will lead to milder temperatures and drier-than-normal weather. This probably is not good news for commodities such as natural gas and businesses affected by it. A warm winter decreases the perceived demand of natural gas, and that has a negative impact on its prices. So you might want to pay close attention if your portfolio has exposure to the following types of companies:
- Exploration and Producing companies (e.g. Chesapeake Energy – CHK)
- Infrastructure companies that operate pipeline (e.g. Kinder Morgan – KMI)
- Energy equipment companies that manufacture containment vessels (Chart Industries – GTLS)
A warm winter has a similar effect on heating oil. Also known as the “no. 2 oil,” heating oil primarily is used to heat homes and buildings by fueling furnaces/boilers. Since it is produced from crude oil, it has a strong relationship with crude, diesel and gasoline. Below is a graph that compares the rate of change of crude prices with correlation of +0.9 (which means they are very closely related).
Now since heating oil and crude prices are closely related, crude demand will affect heating oil prices, which is another factor to consider while investing in heating oil or hedging against it. If your portfolio happens to have exposure to companies that produce, distribute or make equipment for the heating oil industry, you might want to hedge against a short-term fall.
This Year Is Unlike Other Years
A warm winter does put pressure on heating-related energy commodities. However, the prices of energy commodities already have fallen quite a bit in the last one year (S&P GSCI Heating Oil 41% down, Dow Jones Commodity Index Natural Gas 57% down, Dow Jones Commodity Index Crude Oil 54%). You don’t need to be an expert in finance to know there is a possibility for the prices to recover – at least in the short term. That’s just the way markets work. Even if the long-term view is negative (read more about Natural gas outlook in the short term), the prices might recover for a few weeks before going back on a downward trajectory.
The graph below shows that the downtrend started mid 2014 and has continued until today. Highlighted is what happened to crude, heating oil and natural gas in the previous winters. Last winter, we saw heating oil prices go up in January after a significant fall in the preceding six months. This was due in part to rise in demand due to polar vortex, and part because of prices already being significantly down in the preceding months.
The Bottom Line
If a warm winter happens, it will put more pressure on energy commodity prices and affect connected businesses (producers, explorators, distributors, sellers, related equipment manufacturers). If your portfolio has exposure – either via stocks or mutual funds, or derivative instruments – you might want to hedge your risks. Since there already has been a 40-50% correction of prices in the last one year, there might a possibility of a short-term recovery. So if you are planning to go short on, say, natural gas, then look out for news (e.g. change in weather forecast or supply cutdowns) that might send the prices up. Investing in indexes always is better than picking individual stocks, and ETFs certainly make the task easier. If you want to make use of the expected short-term decline in the coming weeks, VelocityShares 3x Long Natural Gas ETN (UGAZ) is a leveraged ETF that will get you a 3x short position in natural gas. Note: leveraged ETFs are only short-term investment tools.
If your long-term view is that commodities are primed to recover in the next one year, this is a good time to dig in and get long positions. United States Diesel Heating Oil Fund (UHN) tracks heating oil prices. United States Natural Gas Fund LP (UNG) tracks natural gas futures.
Here are some more natural gas ETFs you can consider: Top Natural Gas ETFs.
Image courtesy of khunaspix at FreeDigitalPhotos.net
